Netflix Stocks Surge, But Long Term Weighs

Netflix(NFLX) shares shot up over 24% yesterday, to close at $216.99. The rise caps a 134.4% gain since December 31, 2012, when the video service’s stock closed at $92.59.

The company operates in three segments: Domestic Streaming (which supplied 62.4% of Netflix’s revenue in the latest quarter) allows users in the U.S. to view Netflix’s library of movies and TV episodes over the Internet for $7.99 a month; Domestic DVD (23.8% of revenue), which rents out DVDs by mail; and International Streaming (13.9%).

The catalyst for this latest jump was the company’s first quarter earnings report, which it released after markets closed Monday night. Here’s how the numbers looked:

During the quarter, Netflix’s revenue rose 17.7% from a year earlier, from $869.8 million to $1.02 billion. The gain was due to increases at the two streaming divisions: Domestic Streaming sales rose 26.0%, while International Streaming sales more than tripled. The Domestic DVD service’s revenue declined 23.9%, which is the continuation of an ongoing trend.

In all, the company added 3.05 million streaming members in the latest quarter, including 2.03 million in the U.S., to bring its total to 29.17 million. Internationally, it added 1.02 million subscribers, for a total of 7.14 million. Wall Street expected the company to end the quarter with 29 million subscribers in the U.S.

Netflix swung from a year-ago loss of $4.6 million, or $0.08 a share, to a profit of $2.7 million, or $0.05. Excluding a $16-million loss on the extinguishment of debt, net of taxes, the company earned $0.31 a share in the latest quarter. The latest results topped the consensus forecast of $0.19 a share in adjusted profits on revenue of $1.02 billion.

The company is investing in its own content in a bid to attract new subscribers. In February, Netflix released all 13 episodes of its new political drama, House of Cards, which stars Kevin Spacey, at once.

As the Wall Street Journalreported on April 23, it wasn’t entirely clear how much of an impact this series had on the subscriber gains, and CEO Reed Hastings didn’t do much to clarify things after the release. “What we’ve seen with House of Cards is a nice impact but a gentle impact,” he said in the post-earnings conference call.

In his letter to shareholders, he went somewhat further, saying that the series didn’t prompt viewers to jump onboard for the company’s one-month free trial and then vanish after they’d watched the episodes.

“Some investors worried that the House of Cards fans would take advantage of our free trial, watch the show, and then cancel,” he wrote. “However, there was very little free-trial gaming—less than 8,000 people did this—out of millions of free trials in the quarter.”

According to the Journal, the company likely around spent $100 million on the show, including a second season that has not yet been aired. Netflix has plans to keep adding more original content: it just released all 13 episodes of horror thriller Hemlock Grove and will air a fourth season of comedy series Arrested Development, which has a dedicated following but was canceled by Fox in 2006.

“Long term, we believe the value of our original series in driving acquisition and retention improvements will be borne out as we add more seasons of already popular shows like House of Cards and further series. Harry Potter was not a phenomenon in book one, compared to later books in the series,” wrote Hastings.

3 Factors Weighing on Netflix’s Long-Term Prospects

“The stock definitely has price momentum right now and could reach as high as $240 to $250, but the long-term profit prognosis for Netflix remains bleak, and I would rather short the stock than buy it at its currently elevated levels,” said Investing Daily’s Jim Fink in response to Netflix’s latest pop.

As Fink has pointed out in previous articles on the stock, there are formidable hurdles that it must overcome to sustain its long-term growth. Here’s a look at three:

1. Deep-pocketed competition: As Fink illustrated in a September 2011 article, online competitors likeAmazon.com (NasdaqGS: AMZN), as well as cable and wireless companies such as Comcast (NasdaqGS:CMCSA) and Verizon Communications (NYSE: VZ) have greater resources at their disposal than Netflix. Amazon, for instance, ended the latest quarter with cash of $11.5 billion, compared to just $418 million for Netflix. These competitors’ large size and financial clout also give them the ability to outbid Netflix for content and drive up the cost of new programming. They also have more flexibility to build the necessary infrastructure to compete in the streaming market.

“I would say the only thing that’s noticeably changed in the last 12 months is Hulu and Amazon bidding more aggressively, and that that’s made content owners much happier and has made the prices to us higher than they would otherwise be,” Hastings said in the conference call.

In addition, Bloomberg TV points out that Netflix has off-balance-sheet commitments of $5.7 billion for future content, up from $4.8 billion a year ago. For example, as we reported on December 6, 2012, the company has a three-year deal with Walt Disney (NYSE: DIS) that takes effect in 2016. Under the agreement, Netflix is thought to be paying around $300 million annually for the rights to show Disney’s movies.

2. Raising prices is next to impossible: Due to the rising competition, Netflix has not been able to raise its prices above the current $7.99 level. Amazon’s Prime service is, in fact, cheaper than Netflix at $79 annually (compared to a yearly rate of $95.88 for Netflix) and includes free two-day shipping on other purchases. Fink summarized what happened the last time Netflix tried to raise its rates in an October 2011 article:

“CEO Hastings’ disastrous July [2011] decision to raise prices by 60% caused a consumer revolt that resulted in more than 800,000 people dropping their subscriptions. A September apology for the price increase did more harm than good because it was combined with a disastrous announcement that the company was splitting off its DVD rental business into a separate website called Qwikster. Subscribers hated the idea of losing the convenience of a single website to access both DVD rentals and streaming, which led Hastings to backtrack three weeks later and cancel the entire Qwikster plan.”

The company currently limits members to two simultaneous streams. However, according to the shareholder letter, it plans to add a four-stream plan for $11.99 in the U.S., but it expects less than 1% of its members to sign on.

3. Amazon also has a well-thought-out original content strategy: In addition to deeper pockets, Amazon is also planning to move into original content in a way that arguably gives it a better chance at running across a hit show than Netflix. The company recently rolled out pilots of 14 potential new series, which viewers can watch for free on Amazon Instant Video. Amazon will then base its decision on which ones to go ahead with based on the responses they get. The company’s fledgling Amazon Studios division also has 25 projects in development and being tested with audiences, according to Silicon Republic. Courtesy Chad Fraser atInvesting Daily - profitable advise for smart people (EconMatters author archive here) The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.